Variation in the DNA restriction map in the Adh region (alcohol dehydrogenase locus) of chromosome II of Drosophila melanogaster from natural populations was examined. On average, 1 out of 50 nucleotides was observed polymorphic in the 12 kilobase region examined. In addition, we found insertions and deletions to be common, particularly in regions flanking the Adh transcript. All insertions of over 200 nucleotides share sequence homology with known transposable elements. The frequency distribution within Drosophila melanogaster and among related species suggests that such variants are deleterious mutants. Comparisons of Adh gene activity among inserted and noninserted sequences support this view for some variants. The effect of other flanking sequence variants may be on other adjacent genes and/or general chromatin structure. Evidence is found for preferential insertion of transposable elements into sequences implicated as being important in gene regulation (identified by their DNAse I hypersensitivity in intact chromatin). Two levels of Adh activity (high and low) commonly segregating in natural populations appear due to one or more nucleotide substitutions within the transcript that in some way alter standing levels of Adh mRNA (possibly by affecting mRNA stability or processing). These activity level substitutions appear to be distinct from, but in strong nonrandom association with, the two commonly segregating alleles of the protein (which differ by a single amino acid). It is clear that the target for mutations of significant effect is substantially larger than the coding sequence for the gene product.